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Prepackaged insolvency is increasingly popular

When General Motors and Chrysler finally landed in bankruptcy protection this spring, the parties had already worked out many of the details of a final arrangement.

Both automakers were well on their way to securing government financing to keep them afloat, while negotiations with unions had concluded with substantial cuts to their labour costs. In Chrysler’s case, the company had already hammered out an equity deal with Italy’s Fiat SPA.

For the most part, what remained was the task of reducing their debts through talks with their lenders, something they proceeded to undertake through the bankruptcy process before they finally emerged from court protection in recent weeks.

The result was a relatively quick end to Chapter 11 proceedings that threatened - and, of course, may yet be having a negative impact on - the automakers’ sales and bottom lines. But for Kevin McElcheran, a partner in the bankruptcy and restructuring group at McCarthy Tétrault LLP, it’s a scenario that’s becoming increasingly common.

“Having a company for a long time in some kind of insolvency process . . . has a very serious negative impact on the long-term relationship [with customers],” he says.

In the case of Air Canada, for example, its time in protection under the Companies’ Creditors Arrangement Act dragged on for months as it tried to renegotiate almost every aspect of its business, according to McElcheran.

“It seemed like an interminable process,” he says, adding that Stelco Inc., too, suffered when GM announced it wouldn’t renew its contracts with the steelmaker during its 26-month-long bid to emerge from bankruptcy protection.

As an alternative, companies are turning to what McElcheran calls a prepackaged insolvency. “It’s happening pretty frequently and it’s keeping me pretty busy these days,” he says.

Prepackaged scenarios typically come into play where the company has an otherwise viable business that finds itself saddled by debt.

While that might not have been the case with GM and Chrysler, in most instances the issue comes down to a need - often triggered by the breach of a loan condition or obligation - to get some relief from interest payments or get new financing.

In some scenarios, the problem might be that the company took on additional debt during a leveraged buyout. In others, the issue might simply be that the company borrowed too much during the good times figuring it could handle its debts.

“In that sense, it’s easier to do a prepack if you’ve only got the creditors to deal with,” says McElcheran, noting the negotiations get much more complicated when issues such as labour contracts surface.

Often, companies will work to bargain new terms with their lenders before filing. They can include options such as a debt-for-equity swap allowing the company to reduce its interest payments. At the same time, it will typically seek new financing in order to remain afloat.

Then, once it has what appears to be a workable plan that has agreement from enough of the company’s creditors, it will file for CCAA in court in order to finalize the deal.

In the Chrysler case in the United States, for example, the court had the authority to make a ruling approving the terms despite the fact that some parties disagreed with them. As a result, the automaker was able to emerge from Chapter 11 and conclude its partnership with Fiat.

Key to making a prepackaged insolvency work is having a manageable group of shareholders who can deliver the votes necessary to get a plan approved, McElcheran notes.

He distinguishes between prepackaged cases in which a solid group of creditors is already behind a plan of arrangement and pre-negotiated ones where many, but perhaps not enough, of them are in agreement before filing.

In the recent Chapter 11 filing by auto parts maker Lear Corp., for example, the company went into protection last month with significant support from creditors and bondholders for its reorganization plans but without clear backing to get them off the ground. As a result, Lear is seeking court approval of its pre-negotiated plan.

But in an earlier case, that of Meridian Technologies Inc., initial agreement by an overwhelming majority of its secured lenders allowed it to leave CCAA protection within 11 days. There, new financing as well as the lenders’ willingness to exchange debt for equity, allowed a new company, Meridian Lightweight Technologies Inc., to emerge very quickly.

Of course, there are still high-profile exceptions to the preference by some companies for a speedy, pre-arranged bankruptcy process. In the case of Quebecor World Inc., the printing company sat in bankruptcy protection for more than a year until it finally exited last month.

And, of course, Nortel Networks has remained in what has become a messy predicament since its filing in January. In that instance, McElcheran says the company needed to file early in order to bring its stakeholders together.

At the same time, because the outcome wasn’t clear - especially given that options included selling the telecommunications giant - a prepackaged process wouldn’t have been appropriate, he notes.

But given the benefits in preserving a company’s viability and image, McElcheran says a prepackaged option can be the way to go. “For those that have the opportunity to do it, it is the thing to do.”

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